The Role of Financial Development in the Relationship Between Foreign Direct Investment and Economic Growth: A Nonlinear Approach

Abstract

Financial development is recognized as an absorptive capacity in the relationship between foreign direct investment (FDI) and economic growth. Therefore, FDI effect on economic growth is contingent with the level of financial development. However, existing studies also show that financial development dampens economic growth through the “too much finance harms economic growth” hypothesis. Hence, there is a question of how far financial development should be developed to optimize the benefits of FDI on economic growth. The novelty of this study is that it reexamines the role of financial development in FDI-growth relationship by including the interaction term between FDI and the nonlinearity of financial development on economic growth in the period following the 2007–2008 Global Financial Crisis. Interestingly, our results demonstrate that the nonlinear relationship of financial development on economic growth is a U-shaped curve by using data from the 2009–2013 period, for 65 developing countries, which contrast the findings from previous studies. The absorptive capacity effects work nonlinearly, in that FDI accelerates growth after reaching a certain level of financial development, and that the positive effect originates from a minimum level. The study thus suggests that the level of financial development needs to be increased since it serves as a form of absorptive capacity enabling the positive growth effects of FDI in the recipient countries.

Examining Finance-Growth Nexus: Empirical Evidence From the Sub-Regional Economies of Africa

“…Furthermore, a high level of bond market development has a significant effect on foreign capital inflow. Abdul Bahri et al (2019), use co-integration, cross-sectional dependency auto-regressive distributed lag (CS-ARDL), VECM, and FMOLS analysis to explore the upshot of FD on FDI inflows in five economies in Asia including the Philippines, Thailand, Singapore, Malaysia, and Indonesia from 1980 to 2017. They find that the decision of investors relies on the status of the financial system, furthermore, the causality test reveals that there is a short and long-run relationship between FD and FDI inflows.…”

The Optimal Level of Financial Growth in View of a Nonlinear Macroprudential Policy Regime Model: A Bayesian Approach

“…However, Puatwoe and Piabou (2017), in the case of Cameroon, contradict those studies that believe in the negative (Gouider and Trabelsi 2006) and those that believe in a non-monotonic relationship (Samargandi et al 2015). Two years later, a further confirmation of the nonlinearity was documented by Abdul Bahri et al (2019) in a panel of 65 developing countries for the period 2007-2015, using a generalized method of moments (GMM). However, apart from confirming the nonlinearity, they created a further contradiction on the nature of the relationship between financial development and growth, as Samargandi et al (2015) found the inverted U-shape, while Abdul Bahri et al (2019) documented the U-shaped relationship.…”

“…Two years later, a further confirmation of the nonlinearity was documented by Abdul Bahri et al (2019) in a panel of 65 developing countries for the period 2007-2015, using a generalized method of moments (GMM). However, apart from confirming the nonlinearity, they created a further contradiction on the nature of the relationship between financial development and growth, as Samargandi et al (2015) found the inverted U-shape, while Abdul Bahri et al (2019) documented the U-shaped relationship. In the same year, further support for the positive relationship was further documented by Faathih and Mansur (2018) in the case of Bangladesh, using nonlinear autoregressive distributed lag covering the period 1972-2016.…”

“…Some of the studies have found the Schumpeter hypothesis (Goldsmith 1969;Ufuo and Alagidede 2018;Jobarteh and Kaya 2019;Elijah and Hamza 2019;Abeka et al 2021). While others inverted the U-shape (Swamy and Dharani 2019;Abu-Lila et al 2021;Machado et al 2021), others discovered the U-shape (Abdul Bahri et al 2019;Bandura and Dzingirai 2019). Lastly, others found conclusive results (Erkisi 2018).…”

The Interaction Between Financial Development and Economic Growth: A Novel Application of Transfer Entropy and Nonlinear Approach in Algeria

“…For instance, Krinichanskii (2022) identified six mechanisms that cause the nonlinearity of the finance-growth relationship and revealed the properties of this nonlinearity in an empirical analysis of 43 OECD countries from 1990 to 2019. Bahri et al (2018) found that (FD) accelerates (EG) after reaching a turning point, while Bahri et al (2019) showed that FD accelerates growth after a certain level of (FD) is reached.…”